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Vermont Becomes ‘Offshore’ Insurance Haven

Derick A. White, who regulates captive insurers in Vermont.Credit
Caleb Kenna for The New York Times

At conferences of the offshore insurance industry, next to the booth for Bermuda, can often be found one promoting Vermont.

While that may seem strange for a chilly, landlocked state, Vermont is an offshore haven in one very real sense: It offers American companies lucrative tax breaks through unusual insurance arrangements.

“Vermont does the promotion the same way Bermuda does the promotion,” noted Andrew Barile, an insurance industry consultant.

More than 560 United States companies, including Wal-Mart Stores, Starbucks and McGraw-Hill, have set up Vermont-based entities to insure their biggest risks and liabilities, giving them a tax benefit in the process. Vermont now rivals the Cayman Islands and Bermuda as the insurance destination of choice for American companies.

The most recent arrival is Wells Fargo, which was granted a waiver by the federal Labor Department in February to provide life insurance and long-term disability insurance to its 153,000 employees through its own private unrated insurance company in Vermont.

With its wholly owned insurer, known as a captive, Wells Fargo will benefit from improved cash flow, new investment income and tax breaks totaling at least hundreds of millions of dollars over the next 30 to 40 years, according to Karin Landry, an insurance consultant at the Spring Consulting Group in Boston. She does not work on the Wells Fargo captive, and she said she based her estimate on comparable ones for corporate clients of a similar size.

Wells Fargo says that operating a do-it-yourself insurer in Vermont, rather than buying coverage from an independent insurance company, will save it money and increase the benefits it pays to workers.

But Vermont’s success in attracting insurance captives also highlights the many ways that American corporations are allowed to minimize their tax bills by moving their profits, intellectual property or liabilities to places that provide substantial tax advantages, whether it is a Caribbean island, Ireland or Singapore. And while many states in the United States provide tax breaks and subsidies to companies that move or expand operations in state, the benefits offered by Vermont are much larger.

Big financial services companies typically spend $25 million to $100 million a year on insurance coverage. Being insured through a captive cuts that cost for them by 5 percent to 20 percent, according to Nancy Gray of Aon Insurance Managers in Burlington, Vt.

Vermont has had laws allowing insurance captives since the early 1980s. But it was not until the late 1990s that the state began promoting itself as an alternative to traditional offshore insurance arrangements. In 2001, the governor at that time, Howard Dean, declared that the state would “overtake Bermuda” as the place with the most insurance captives.

The captive insurance industry, including insurers and the law firms that service the captives, is now one of the 10 biggest employers in the state. And while the companies set up captives to minimize federal taxes, the state taxes they pay on premiums account for about 2 percent of Vermont’s annual budget, according to Daniel D. Towle, the director of financial services at the Vermont Department of Economic Development.

“It’s a great industry for a small state,” he said, adding that insurance industry conferences in the state also bolster tourism revenue.

Most of the captive managers and service providers are in Burlington, in two buildings that overlook Lake Champlain. The state’s annual captive conference in August features a golf tournament and attracts industry executives from around the world, including the Caribbean.

“It’s the largest of its kind in the world,” Mr. Towle said.

Global tax havens typically tend to be in small countries with a strong rule of law. Vermont, with its captive insurance industry, is no exception.

“Our economic development people thought that for Vermont, like any small state with a small economy, this would be a perfect fit,” said Molly Lambert, president of the Vermont Captive Insurance Association.

It probably also helps that Vermont, known for its dairy farms and covered bridges, has a squeaky-clean image compared with Caribbean havens that have been in the news because of money laundering and other shady dealings.

At first, the captives set up in Vermont were used to insure companies’ warehouses or oil rigs or to indemnify executives. In recent years, however, a growing number of companies have been setting up captives to insure their employee benefits.

Nearly a dozen large companies, like Archer Daniels Midland, H. J. Heinz, Alcoa and Sun Microsystems, have won approval from the Labor Department to put employee benefits like medical and life insurance into their private insurers. More than two dozen states, South Carolina, Arizona and Hawaii among them, also have laws that allow private insurers, but eight of the approved companies have chosen Vermont for their benefits captives.

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Now some companies are looking to put their pensions into their Vermont insurers, according to Ms. Landry.

She said that as work forces age, medical costs rise and companies increasingly seek to deal with all their risks by themselves, private insurers are “an attractive option” that can bridge the gap between “buying traditional insurance or eliminating the benefits altogether.”

Federal pension regulations include safeguards intended to ensure that employers do not abandon covered workers. The Employee Retirement Income Security Act, or Erisa, covers employee benefits from pensions to insurance for group life policies, health, long-term disability and accidents. Among the safeguards was a rule that functionally prevented private insurers from handling employee benefits.

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But in 2000, at the urging of Columbia Energy, now called NiSource, the Labor Department relaxed that safeguard, allowing the utility to become the first company to manage Erisa-regulated employee benefits through a wholly owned private insurer, based in Vermont.

To deflect criticism, the agency introduced new safeguards. Among them is a requirement that captives insuring or reinsuring Erisa benefits have their policies initially written by a major, respected insurer before that insurer turns the policies over to the captive. They also had to hire an independent fiduciary, not overcharge the employees, promise to increase the benefits to employees and set the insurer up in the United States, not in the Caribbean.

“As regulators, we have a little more responsibility, because we’re also insuring the employee, who is not a sophisticated buyer,” said Derick A. White, director of the captive insurance division at the Department of Banking, Insurance, Securities and Health Care Administration of Vermont.

Still, Mr. Barile, the industry consultant, says such arrangements are likely to prompt lawsuits from employees whose claims are denied by their employers.

For years, Wells Fargo has been using its Vermont insurance subsidiary, Superior Guaranty Insurance Company, to insure most of its other risks, like those for its property — the bank’s headquarters are in earthquake-prone San Francisco — and those for its top executives, should the company ever face a financial scandal, as well as its auto warranties.

With its captive, Wells Fargo will be setting the rates and paying itself. Wells Fargo pays MetLife and Minnesota Life “fronting fees” to issue life and long-term disability insurance policies for the entire company through the bank’s private insurance subsidiary. Then, MetLife and Minnesota Life transfer the risk of the insurance to Wells Fargo’s wholly owned Vermont subsidiary.

Wells Fargo sets the rates for the policies, and sells them to itself, with employees paying monthly premiums to their employer.

Because Well Fargo pays the benefits premiums to itself, rather than to MetLife and Minnesota Life, it can deduct all premiums for all of the insurance, including property and casualty and director and officers, in its captive. Under Internal Revenue Service rules, employee benefits in captives are unrelated business that makes all the business of the captive deductible.

William J. Thompson, an actuarial consultant who is the independent fiduciary hired by Wells Fargo under Labor Department rules to review the financial health of the private insurer, said that “one of the reasons employers are looking to do this is to get the unrelated business up to get the tax benefit.”

But Wells Fargo may also have an incentive to charge itself lower premiums, to help keep costs down. Wells Fargo can also use the steady income of monthly premiums from employees to generate investment income.

The Vermont subsidiary will be liable for the policies unless it takes out a layer of its own reinsurance, which would transfer some of the risk back to a mainstream insurer like MetLife.

Proponents say that putting all sorts of different risks into a single insurer dilutes the risk to any single type of insurance. But critics contend that the arrangement can mask risks.

“With Enron still blazed on every employee’s memory banks, it is a worry that all of our life insurance, workers compensation, long-term disability and our 401(k) retirement and employee cash balance plan is all heavily invested in Wells Fargo subsidiaries and/or managed by them,” a Wells Fargo employee, Bill Malak, wrote to the Labor Department in January, as part of a process allowing employees to comment upon the proposal.

Mr. Malak works for a separate Wells Fargo insurance subsidiary, Accordia. He wrote that he was worried that the Wells Fargo subsidiary, Superior Guaranty Insurance, was capitalized at only $57 million.

Wells Fargo declined to comment on the specifics of its reinsurance, but an outside lawyer for the bank from the Groom Law Group, a prominent benefits law firm, wrote to the Labor Department in January saying that the captive had adequate capital and was covered by reinsurance.

Still, in a brief telephone interview, Mr. Thompson, the independent fiduciary for the Wells Fargo private insurer, acknowledged that “captives aren’t as strongly capitalized, so it’s a more risky venture.”

A version of this article appears in print on , on Page C1 of the New York edition with the headline: Vermont Becomes ‘Offshore’ Insurance Haven. Order Reprints|Today's Paper|Subscribe